1. Supply and Demand of Physician Services
Econ

2. Supply and Demand of Physician Services: Outline
A. General Models
B. Forms of Compensation
C. Physician-Induced Demand

3. General Models: Outline
I. Supply of Physicians
II. Supply of Physician Services
a. Model with Complete Information
b. Incomplete Information
c. Objectives Besides Income

4. I. Supply of Physicians Summary Statistics (U.S.; 1994)
126 medical schools
16,000 graduates per year
550,000 practicing physicians
254 physicians per 100,000 residents
Average net income : $182,400
Average work hours: 55/week
Physicians work a lot and make a lot
Market forces or shortage?

5. I. Supply of Physicians Market distortions Barriers to entry
Educational and licensing requirements
AMA controls these; incentive to restrict supply too much?
This would reduce supply below socially optimal level
Medical school subsidies
Could raise supply above socially optimal level

6. I. Supply of Physicians Empirical Evidence
Difficult to measure physician shortages or excess returns on investments in medical education
Supply side: new medical school graduates constant
Demand side: average age, real per capita GDP, and insurance coverage all increased dramatically
Consistent with excessively restricted entry
More recently
Output of medical schools has expanded dramatically in last years
Weeks et al. (1994): returns to education for physicians, lawyers, dentists, and MBAs all similar

7. II. Supply of Physician Services a. Model with Complete Information
Monopolistic Competition
Many sellers
Differentiated products (physicians are imperfect substitutes)
Some market power
Demand exogenous from physician’s perspective
Perfect information on both sides
Physicians maximize profit
Nonretradable goods

8. II. Supply of Physician Services a. Model with Complete Information
Physician makes “all or nothing” offer to patient, who would prefer to consume less care at the given price
Physician can price discriminate
If price set by demand side (i.e. insurance companies/Medicare), physician responds by increasing quantity
Quality of service is another dimension to consider

9. II. Supply of Physician Services b. Incomplete Information
Punch line from part a: Even with perfect information, the differentiated and nonretradable nature of medical goods can keep medical expenditures above competitive levels.
Relaxing the assumption of perfect information further enhances our understanding of why medical expenditures are so high.

10. II. Supply of Physician Services b. Incomplete Information
1) Irreducible uncertainty
Doctors and patients have imperfect information about the underlying condition and effectiveness of treatments
Most doctors and patients are risk averse
=> increased test frequency and treatment intensity

11. II. Supply of Physician Services b. Incomplete Information
2) Principal-agent problem
Principal: patient
Agent: doctor
Doctors know more than patients about appropriate level of care (asymmetric information)
Outcomes are often difficult for patient to observe
Often gray areas about appropriate treatment
=> Could lead to excessive provision of care
“Induced demand”

12. II. Supply of Physician Services b. Incomplete Information
3) Unobservable physician quality
Large fixed cost with trying a new physician
Information asymmetry makes it hard to observe physician quality
=> Prices may not fully adjust to an increase in competition

13. II. Supply of Physician Services c. Objectives Besides Income
Parts a and b assume that physicians act to maximize income. Other considerations:
1) Medical ethics: legal and moral constraints
2) Patient’s best interest (patient’s utility enters into doctor’s utility function)
Patient’s utility, not society’s utility. Why is this an important distinction?
3) Target income

14. II. Supply of Physician Services c. Objectives Besides Income
3) Target income
Motivation: explain positive association between physicians per capita and prices of services, negative association between fees paid and quantity supplied
Physicians aim to maintain a “target income”
If increased competition lowers their income, they take advantage of their market power by raising prices or inducing demand to keep income relatively stable
What does this say about physician behavior before the increase in competition?

15. II. Supply of Physician Services c. Objectives Besides Income
3) Target income
Taken seriously for a long time
Generally rejected now, though still subject of debate in literature
If target income hypothesis is true, there should be large income effects on supply (identified using non-labor income), and this doesn’t seem to be the case
Can you think of other explanations for the apparent paradoxes?

16. Forms of Compensation I. Fee-for-service II. Capitation III. Salary
IV. Pay-for-performance

17. I. Fee-for-service
Physicians are paid an additional amount of money for each service they provide
Would expect this to increase the amount of care provided
Open question how much these additional services would improve health
Schuster et al. (1998) estimate up to 30% of services are not medically necessary
Often supplemented with incentives to economize

18. I. Fee-for-service Who sets the fees? Used to be physicians
In response to incentive problems, insurance plans began negotiating fees and Medicare began setting fees
These groups can do this because they are large enough that they have market power (monopsony)
How does this tie into the “public option” debate?

19. II. Capitation
Physicians receive fixed amount of money for providing services to a patient for a particular period of time
Incentive to keep long patient roster but give them each as little attention as possible
Could lead to higher referral rates
Various schemes to makes physicians share in financial risk
Still need to provide enough care to attract and retain patients
Incentive to select healthy patients (cream skimming; cherry picking)
Fee for a patient is “risk adjusted” based on expected utilization
This adjustment only accounts for 10% of variation
Often supplemented with incentives to ensure sufficient quality of care
Could be combined with ffs in a “mixed” system

20. II. Capitation Quantity
Capitation seems to be effective in reducing quantity and expenditures (is this good?)
Stearns et al. (1992)
Group of WI employees enrolled in IPA
Change from ffs to capitation system where physicians shared in financial risk of hospitatlization and specialty costs
Increased primary care visits by 18%
Decreased specialist visits by 45%, hospital visits by 16%, and length of stay by 12%

21. II. Capitation Quantity Ogden et al. (1990)
Group of IL employees enrolled in IPA
Switched from ffs to capitation with shared financial risk
Specialist costs increased 2% compared to 12% the previous year
Hospital outpatient costs dropped 7% compared to increasing 12% the previous year
Little change in inpatient hospital utilization

22. II. Capitation Quantity Mooney (1994)
GPs in Copenhagen, Denmark switched from capitation to mixed capitation-ffs
Provision of services that provided extra fees increased dramatically
Decrease in referrals to specialists and hospitals

23. II. Capitation
Quality
Sorbero et al. (2003): patients 36% more likely to switch physicians under capitation than ffs
Shen et al. (2004): survey with hypothetical treatment decisions; physicians more “bothered” by their decisions under capitation than ffs

24. II. Capitation Referral rate
Capitation does seem to lead to more referrals on the margin, both theoretically and empirically, if the GP does not share in the financial risk
Theoretical: Barros and Martinez-Giralt (2003); Iverson and Luras (2000b)
Empirical: Forrest et al. (2003); Carlsen and Norheim (2003)

25. III. Salary
Provides fixed income to physician over a particular time period
Ex. in US: Staff HMOs
Incentive to do as little as possible to keep job
Often supplemented with incentives to ensure reasonable quantity and quality of care
Less common than others, but do see it in national health systems like UK and staff HMOs in US

26. IV. Pay-for-performance
Ties part of physician or hospital reimbursement to meeting performance thresholds (clinical outcomes, patient satisfaction, etc.)
New and largely untested
>20 million in US covered (Rosenthal et al., 2004)
Difficult to measure “performance”
What incentive problems might result from paying on the basis of outcomes?

27. Physician-Induced Demand
I. Theory
II. Evidence from Increased Competition
III. Evidence from Decreased Fees
IV. Summary

28. I. Theory
Physician-induced demand (PIP): “when the physician influences a patient’s demand for care against the physician’s interpretation of the best interest of the patient” (Handbook, p. 504)
Physician exploits role as agent to alter the patient’s demand curve
Distinctions that make PID challenging to identify empirically (not enough to just look at quantity)
Useful agency v. inducement
Demand shifting v. quantity setting

29. I. Theory
Model
Where Y=income, I=inducement, N=number of patients, m=margin, x=quantity, i=inducement
Solving yields

30. I. Theory Testable prediction 1
N down => Y down and I down => UI less negative and UY up => -UI/UY down => x1’ and x2’ down => i1 and i2 up.
So, increased competition for patients should increase the per-patient quantity of services
Supply side: more physicians in market
Demand side: less need for services
Depends on changing tradeoff between I and Y as income changes (income effect)

31. I. Theory Testable prediction 2
m1 down => UY up => -UI/UY down => i1 and i2 up
Income effect
m1 down => lower return to inducement in sector 1 => i1 down and i2 up
Substitution effect
Net effect on i1 ambiguous; net effect on i2 down
So, a drop in fees from one payer should increase quantity among patients with another payer

32. II. Evidence from Increased Competition
Effect of increase in per capita number of physicians on quantity
Problems
Really tests joint hypothesis of induced demand and income effects
Endogeneity of number of physicians (likely a response to demand)

33. II. Evidence from Increased Competition
Fuchs (1978)
Effect of supply of surgeons on surgeries
22 metropolitan areas, pooled cross sections from 1963 and 1970
IVs: metro area, hotel receipts, percent white
10% increase in surgeons => 3% increase in surgeries
Cromwell and Mitchell (1986)
More years, more areas, better controls
Same identification strategy
Same sign, smaller effect
Birch (1988) and Grytten el at. (1990)
More dentists per capita => more dental visits

34. II. Evidence from Increased Competition
Rossiter and Wilensky (1983, 1984); Scott and Shell (1997)
Small effects of physician density on quantity for some procedures
Dranove and Wehner (1994)
Falsification test: estimated “effect” of number of obstetricians on volume of births
Similar IV methodology to Fuchs and Cromwell and Mitchell
Found positive effect; suggests methodology is suspect

35. II. Evidence from Increased Competition
Gruber and Owings (1996)
13.5% fall in fertility from represents exogenous shock to incomes of OB/GYNs
Exploited between-state over-time variation in fertility rates to identify effect on Caesarian section deliveries (more lucrative)
10% drop in fertility => 0.6% increase in P(C-section)

36. II. Evidence from Increased Competition
Pauly (1980)
Used large individual-level dataset
Least informed patients should be the most susceptible to demand inducement
Poor patients in big cities should be the least informed
Found (small) effect of number of physicians on quantity of ambulatory care for this group

37. III. Evidence from Decreased Fees
Hadley and Lee (1978); Mitchell et al (1989)
Medicare price freezes during 1970s and 1980s led to increased utilization
Hurley et al. (1990); Hurley and Labelle (1995); Escarce (1993b)
No clear evidence of effect of own-fee changes on utilization
Not surprising; theoretical prediction ambiguous
Rochaix (1993)
GPs in Quebec changed mix of services in response to lowering of fees

38. III. Evidence from Decreased Fees
Rice (1983)
1977: Medicare began setting fees in Colorado based on state-wide averages
Reduced fees in Denver-Boulder area; increased them in other areas
Physicians facing declining rates increased provision of surgery, medical services, and tests

39. III. Evidence from Decreased Fees
Nguyen and Derrick (1997)
Impact of Medicare fee reductions for “overpriced procedures”
For 20% of physicians who experienced the largest price reductions, 1% reduction in price => 0.4% increase in volume.
Yip (1998)
Reductions in Medicare fees for thoracic surgeons led to large increases in volume
Surgeons recouped 70% of lost income

40. IV. Summary
There is no perfect test for demand inducement, but theory generates predictions that lead to tests that are suggestive.
“It appears that, in response to economic considerations … physicians can induce demand for their services, they sometimes do induce demand, but that such responses are nether automatic nor unrestrained” (Elgar p. 265, citing Hurley and Lebelle, 1995).